Stock Market

Stock Market

The various organized stock exchanges and over-the-counter markets.

The trading of Securities such as stocks and bonds is conducted in stock exchanges, which are grouped under the general term stock market. The stock market is an important institution for capitalist countries because it encourages investment in corporate securities, providing capital for new businesses and income for investors. In the 1990s large numbers of ordinary persons came to own stock through Pension funds, deferred employee savings plans, investment clubs, or mutual funds.

The New York Stock Exchange is the oldest (formed in 1792) and largest stock exchange in the United States, but other exchanges operate in many major U.S. cities. The activities of the stock market are closely monitored by the federal Securities and Exchange Commission to prevent the manipulation of stock prices and other activities that lessen investor confidence.

Stock exchanges are private organizations with a limited number of members. Stock brokerage houses generally cannot purchase seats on an exchange. Instead, a member of the firm holds a seat personally. In some cases several partners of a brokerage house will be members of an exchange. The price of a seat fluctuates depending on the state of the economy, but seats on the New York Stock Exchange have sold for more than $1 million.

Some exchange members are specialists in particular types of securities, while others act as agents for other brokers. A small number of brokers who pay an annual fee but are not members also have access to the trading floor.

A stock exchange is essentially a marketplace for stocks and bonds, with stockbrokers earning small commissions on each transaction they make. Stocks that are handled by one or more stock exchanges are called listed stocks. For a corporation's stock to be listed on an exchange, the company must meet certain exchange requirements. Each exchange has its own criteria and standards, but in general a company must show that it has sufficient capital and is in sound financial condition. Once a company is listed, trading in its stock will be suspended if the company's financial condition deteriorates to the point that it no longer meets the exchange's minimum requirements.

When individuals wish to purchase a stock, they place an order with a brokerage house. The Broker gets a quotation or price and sends the order to the firm's representative on the floor of the stock exchange. The representative negotiates the sale and notifies the brokerage house. Transactions happen rapidly, and each one is recorded on a computer system and sent immediately to an electronic ticker that displays stock information on a screen. At one time this information was generally only available at stock brokerage houses, but the daily stock ticker is now available on television and through the Internet.

New York Stock Exchange transactions may be made in three ways. A cash transaction requires payment and delivery of the stock on the day of purchase. A regular transaction requires payment and delivery of the stock by noon on the third day following a full business day. Around 95 percent of stock is purchased under these terms. Finally, purchase can be made through a seller's option contract, which requires payment and delivery of the stock within any specified time not exceeding 60 days, though seven days is the most common period.

All transactions not made in the stock exchanges take place in over-the-counter (OTC) trading. An OTC transaction is not an auction on the stock exchange floor but a negotiation between a seller and a buyer. Most sales of bonds occur in OTC trading as do most new issues of securities. In the 1980s discount OTC brokerage firms appeared, offering lower commissions on stock transactions for investors who were willing to do more research on their own. By the 1990s these firms had proliferated.

Dealers in OTC trading are not confined just to large cities, as are stock exchanges, but can be found in many locations throughout the United States. In 1971 these firms were linked to an electronic communications system and became the National Association of Securities Dealers Automated Quotations (NASDAQ). By the 1990s NASDAQ had become the second largest U.S. stock market.

During the late 1990s, a number of investors began engaging in a process called "day trading," whereby investors would purchase stock shares and then attempt to sell them quickly thereafter when the prices rose. The phenomenon corresponded with the development of stock trading over the Internet, which allowed individuals to trade stocks through their computers without the need for a stockbroker. Many individuals who traded over the Internet also engaged in day trading. Although day trading has some potential for success, analysts have warned that investments take time to develop in order to be successful. Statistics

Dow Jones Performance After Major U.S. National Security Events

Event

Date

% Change for Daya

6-Months Later

1-Year Later

aIf the event occurred after the U.S. market closed or on a non-trading day, the % change for day reflects the next trading day's activity.

source: Dow Jones web page.

Terrorist Attack

09/11/01

−7.12%

10.47%

−10.66%

Oklahoma Bombing

04/19/95

0.68%

14.92%

32.46%

WTC Bombing

02/26/93

0.17%

8.41%

14.07%

Operation Desert Storm

01/16/91

4.57%

18.73%

30.14%

Panama & Noriega

12/15/89

−1.53%

7.17%

−5.32%

Reagan Shot

03/30/81

−0.26%

−14.56%

−17.12%

Vietnam Conflict

02/26/65

−0.41%

−0.81%

5.48%

Kennedy Assassination

11/22/63

−2.89%

12.04%

21.58%

Sputnik Launched

10/04/57

−2.01%

−4.59%

15.60%

Korean War

06/25/50

−4.65%

2.36%

9.34%

Pearl Harbor

12/07/41

−3.50%

−9.48%

−1.37%

Lusitania Sinks

05/07/15

−4.54%

36.01%

32.75%

showed that only 10 percent of day traders maintained profitable results, and by the early 2000s, it had become clear that this type of trading would likely result in losses for investors.

The health of the U.S. economy is typically measured by the stock market. When stock prices rise and there is a "bull market," U.S. business is assumed to be doing well. When stock prices fall and there is a "bear market," a downturn in business and the economy is assumed.

The stock market suffered through the early 2000s as a number of major events caused the U.S. economy to take a sharp downturn. The september 11th terrorist attacks in 2001 caused the New York Stock Exchange (NYSE) to close for a period of six days, the longest closing since 1933. On Monday, September 17, the Dow Jones Industrial Average suffered its greatest point loss in history after the NYSE reopened following the attacks. The U.S. economy slumped after the attacks, and the stock market continued to struggle through much of 2003.

Scandals involving major U.S. corporations had a similarly crippling effect on the stock market. Several large companies were found to have misstated their earnings through faulty or fraudulent accounting practices. In many of these cases, the companies overstated their profits, misleading their investors. Companies involved in such scandals included Enron Corporation, WorldCom, Adelphia, and Xerox. The scandal involving Enron also led to the conviction of accounting firm Arthur Andersen, L.L.P. for obstructing justice when the firm admitted to destroying thousands of Enron documents.

The scandals have led to widespread mis-trust of the U.S. corporate world. The SEC issued new rules during 2002 and 2003 regarding accounting practices and conflicts of interest among corporate officers in response to the scandals. The rules were designed to regain the trust of the public and investors following the scandals, but the stock market continued to fluctuate throughout much of 2003.

Further readings

"Stocks Close Down in Anniversary Week." CBSNews.com. Available online at <www.cbsnews.com/stories/2002/09/23/national/main523025.shtml> (accessed August 8, 2003).

"Wall Street Scandals at a Glance." BBC News. Available online at <www.news.bbc.co.uk/1/hi/business/2066962.stm> (accessed August 8, 2003).

In fact, Hackett found that companies that have centralized their systems as part of automating and being more strategic in their planning and budgeting are delivering more than twice the equity market returns of their peer group.

The emergence of the limited partnership as the dominant form of intermediary is a result of the extreme information asymmetries and potential incentive problems that arise in the private equity market.

The main factors impacting the funding ratio of a typical US defined benefit plan are equity market returns, which grow (or shrink) the asset pool from which plan participant's benefits are paid; and liability returns, which move inversely to interest rates.

Thus, given appropriate diversification, it's more important to have an optimal exposure to the equity market in the aggregate rather than to have picked a couple of stocks that turn out to be winners.

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